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June 30, 2004

The Curse of Oil


by Thomas Gale Moore

The Bush Administration has made much of Iraq's oil reserves. It wants to use the proceeds from the sale of petroleum to pay off the country's debts, cover the costs of reconstruction and government expenses. It has been hectoring European governments and the Russian government to write off much of the debt that Iraq owes them so that the money can be spent on rebuilding that devastated country. In general, most people and governments have viewed Iraqi oil as a boon; but its existence has major downsides. Oil is more of a curse than a benefit.

First is the quandary it creates for possession of the oil fields. Kirkuk is surrounded by the northern oil fields, which represent about 40 percent of all oil in Iraq. The city of Kirkuk includes Kurds, Arabs, Turkmens, and Assyrian Christians. Except for the Christians, each group claims to be the largest. During Saddam Hussein's regime, Arabs were encouraged to migrate to the region and occupy farms and houses. In many cases Kurds were forced out of their properties, which were turned over to the newcomers. Now the shoe is on the other foot and Kurds are returning to the region and demanding their property. In many cases they are forcing the Arabs out of homes they have occupied for many years. The Kurds would like to make Kirkuk their capital or at least part of the territory they control. The Arabs want Kirkuk to be part of Iraq, run by the central government. Turkey has a strong interest in protecting the well-being of the Turkmens. In any case, whoever possesses Kirkuk will have control over much of Iraqi oil. This is a recipe for civil war.

Although most observers are aware of the problems of Kirkuk and its oil riches, there are two other major dilemmas that have received little attention in the media or, apparently, in the policy-making community. Together these undercut the possibility of establishing a working democracy. Economists call one of these the "Dutch Disease," after the difficulties that country faced with the discovery and development of large natural gas reserves. The export of oil or natural gas in large quantities leads everywhere to an appreciation in the value of the local currency. That in turn means that all imports, such as agricultural products, consumer goods, and manufactures, all become cheaper and drive the local producers out of business. The country therefore becomes increasingly dependent on the export of the oil or natural gas, the revenues of which usually go in large measures to the government.

Another dilemma arises immediately; the government collecting these large sums has less need to tax its people. It is taxation, however, that leads to representative government. Remember the motto during the American Revolution, "No taxation without representation." English and French history demonstrates this clearly. The kings in England had to go to Parliament to raise the sums they needed. In France, the kings had other sources of money and so avoided calling the Etats-Généraux together. The result was the development of democracy in England and an autocratic government in France.

With large oil revenues, which make farming and manufacturing unprofitable, much of the labor force looks to the government, either for handouts or for jobs. Saudi Arabia is a clear example. The revenues from oil in that Kingdom have enabled the government to provide free medical care, free education, and cheap fuels, while employing foreign workers to do the dirty work. Since the Saudi Government has no need for tax revenue from its citizens, it simply attempts to buy the approval of the public. It offers neither freedom nor democracy but bread and circuses. On the other hand, a government that must raise its revenue from its people is limited in attempting to obtain support through state largess. Offering benefits to one group requires taxing others to pay the bill, thus restricting government's power to buy support.

Iraq, with the second largest oil reserves in the world, is a classic example of these problems. Saddam Hussein bought support by paying his police and Republican Guards well to keep his people in line and by subsidizing gasoline to build support. In Baghdad gasoline currently sells for about 5 cents a gallon at the pump. The government buys refined gasoline from Kuwait at world prices and then subsidizes its sale to local consumers. (This leads to a few individuals buying gas cheap and smuggling it out of the country.) Even Paul Bremer, the dictator of Iraq during the occupation, felt he could not raise the local price of gasoline to world levels. Nor could he privatized the oil fields which would have reduced the government's earnings from oil and thereby made it more difficult to operate without taxes.

Iraqi dates, which were once well known around the world, have suffered from the "Dutch" disease and are no longer exported. With an inflated Iraqi currency, they have become too expensive to sell in world markets. As Iraqi oil sales have resumed, the new Iraqi currency has strengthened making imports cheaper and exports more difficult.

Assuming that a democratic government emerges in Iraq an extremely unlikely event, especially in light of the Kirkuk problem those running for office will want to use the oil revenues to buy support. Cheap fuel for autos will continue. Government employment will be provided for much of the population. Since only through the government will a person be able to get ahead, controlling it will become paramount, thus making a democratic system unlikely to last long. The dependence on imports results in a small private sector confined mainly to retailing. Democracy, however, requires that there be a thriving private sector. For one thing, those politicians who fail at the ballot box must have some reasonable alternative way to earn a living. It also requires that government be dependent on revenues raised through taxes on the people in the private sector. Otherwise the government can enslave its people by simply buying the loyalty of the police and military.

It is not coincidental that the only Moslem country with a working democracy is Turkey, which has no oil. Malaysia is also semi-democratic and "suffers" from not being mineral-rich. Norway, which has large oil fields, was a democracy before oil was discovered and has banked the oil income for a future when the fields become dry. The government has effectively sterilized the revenues, preventing the destruction of local industry and the tendency to bribe the public through government programs.

What can be done about Iraq and its oil? Is it condemned to autocracy? Perhaps not, given some thought. To begin with, reducing the size of Iraq's debt makes the problems worse, not better. If, for example, servicing the debt took all of the oil revenues, then there would be no effect on the exchange rate and local industry could flourish. Moreover, the government would have no money left and would have to resort to taxation. As a consequence in order to have something to tax, it would have to foster local businesses. If it had to tax, it would face pressure to get permission from taxpayers hence democracy.

If the debt is reduced or if it takes less than the entire earnings from oil, securing conditions for a democracy would require that the excess revenues be sterilized or spent by the government on imports that were not competitive with local products. It would require that gasoline prices be increased slowly to world levels. As the government did this, it could rebate the higher revenues to the poorest of the public. How to prevent a government that is initially democratic from offering bribes to its people through government jobs and handouts, thus making a return to autocratic government likely, will take much thought and planning. It may be an insoluble problem, but this administration and the next should devote time and energy into trying to find a solution.

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Thomas Gale Moore is a senior fellow at the Hoover Institution, Stanford University. He has a Ph.D. from the University of Chicago in economics and has taught at Carnegie Institution of Technology (now Carnegie Mellon University), Michigan State University, UCLA, and in the Stanford Business School. He has written numerous peer-reviewed economic articles and several books.

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